The Secret Champion of Video Gaming Stocks

What's the most popular video game in the world? You might think it's Angry Birds, with over a billion downloads since it was first released. That makes it the most widely distributed game of all time, but it rarely holds players' attentions for long. Maybe it's Activision Blizzard's (Nasdaq: ATVI) World of Warcraft, which recently bounced back over 10 million subscribers, or Activision's Call of Duty franchise, which claimed 40 million monthly players across all games earlier this year.

You're close, but not quite. A few days ago, Riot Games, the developers of League of Legends (or LoL) released statistics that blow Activision's best out of the water. The competitive team-based PC game most non-gamers have never heard of claims 12 million daily players, of which up to 3 million may be online at the same time. Compare that to Modern Warfare 3, the latest Call of Duty game, which had 3.3 million daily users, with 1.4 million concurrently active, at the peak of its popularity.

Legendary success Every month, LoL players invest over a billion cumulative hours into the game, which makes it, in Riot Games' assessment, the most-played video game in the world. Not bad for a game that's only been active for three years, which began as an outgrowth of a popular multiplayer map for Blizzard's Warcraft III. In a way, Warcraft III could be responsible for creating both Activision Blizzard's biggest cash cow and its biggest threat. Earlier this month, over 7,000 LoL fans gathered in Los Angeles for the game's world championships, an event not unlike the StarCraft tournaments in game-crazy South Korea, to see a Taiwanese team take home a $1 million grand prize. Blizzard, on the other hand, canceled this year's BlizzCon, despite its potential to stage similarly intense StarCraft tournaments.

Riot Games was bought by Chinese online giant Tencent (NASDAQOTH: TCEHY) last year for $400 million. The Chinese company earned just over half its $1.7 billion in second-quarter revenue from its games division, with much of its growth coming outside of China. LoL proves that the freemium business model can work if it supports the right type of game. Players aren't pressured to buy anything to speed up their experience, which usually becomes frenetic anyway as players progress through a typical half-hour game. Still, the unique powers of a new character (which are regularly added to the game), or the bonus of additional skill points, are compelling propositions for competitive players.

Where the model breaks down Premium sales for otherwise free games don't always work as a long-term business strategy. Zynga's (Nasdaq: ZNGA) an ideal case study here. It continues to revise key estimates lower. Its games don't capture gamers for long, resulting in rapidly dwindling player counts from a very early peak. Executive after executive has already jumped ship. Why is that?

Maybe it's because, when it comes down to it, Zynga's products are more chores than games. Kirk Hamilton's review of FarmVille 2 (which now has over 50 million monthly active users and nearly 9 million daily players since launching a month and a half ago) on Kotaku had a lot of great descriptions of what it feels like to play a Zynga game. They all boil down best into this sentence: "Now that I've got everything unlocked, the game has lost any sense of discovery and become a grind of busywork." Zynga's business model has little room for fun, as evidenced by VP Tim LeTourneau's comments in another Kotaku article. Here's some snippets:

"[It's] not that you win FarmVille, but that you feel like you're making progress."

"I'd say first and foremost, in most social games, what you're really combatting is time."

"It's not about somebody pushing the button. It's about somebody pushing the button again."

Push the button again! "A grind of busywork" is the perfect expression of what it feels like to play a Zynga game, and the only ways to push past that grind are to harass your Facebook friends or buy in-game things. Its games exemplify the "Skinner box" design standard of many low-end freemium games, both on Facebook (Nasdaq: FB) and on smartphones. Instead of creating an engaging play experience, these games "play on deep-rooted psychological impulses to make money from their audiences," in the words of an Atlantic article published shortly after Zynga went public.

A Skinner box, by the way, is simply a psychological testing tool that examined addiction in rats. Push the button, get a food pellet. Push the button again. And so on.

Some will fall into this button-pushing cycle and will add to Zynga's coffers, but the strategy has diminishing returns as the same exact format gets recycled into newer titles and gamers become familiar (and bored) with it. According to a Playnomics social-gaming engagement study, 95% of social gamers who joined a new game at the beginning of this year's third quarter were gone by the end of it, and 85% of social gamers got bored after the very first day.

Franchise potential Does this mean LoL will outlast Zynga? It may, and it may very well not. All games get old, even World of Warcraft. That's why there are sequels and expansion packs (or new characters, in LoL's case). One of the reasons why Activision's withstood the steep drops hitting most of its American video game peers is that it's been remarkably successful at maintaining interest in its sequels and expansions. However, I've pointed out several times that interest in Call of Duty seems to be in decline, and a fumbling Diablo III launch resulted in big player losses after a huge number of early sales.

Public perception can quickly turn against a franchise that wears out its welcome. Activision knows this, as it was forced to retire the Guitar Hero series after a flood of underwhelming sequels and spinoffs caused franchise sales to collapse.

What other gaming company can still wring growth out of its biggest properties? Electronic Arts (Nasdaq: EA) has several notable franchises, but over the past few years none have been enough to take its finances to the next level. Take-Two Interactive (Nasdaq: TTWO) is all about Grand Theft Auto, but the latest installment has no official release date, leaving investors waiting for the long development cycle to wrap up.

Tomorrow's entertainment empire? Let's consider Ubisoft (NASDAQOTH: UBSFF.DL.P), the French developer behind the Assassin's Creed series and Prince of Persia. Its ADR shares, at a 16.9 P/E, are right in line with Activision's current valuation. It's had remarkable success with Assassin's Creed, which has sold 39 million copies across all titles so far , a number which will soon increase dramatically with the release of the hotly anticipated Assassin's Creed III sequel at the end of the month. In comparison, Prince of Persia, which was turned into $335 million global blockbuster in 2010, has only sold 12.5 million cumulative copies.

The lessons of the Prince of Persia movie (a disappointment despite its take) led Ubisoft to form its own film studio last year, primarily to develop an Assassin's Creed film franchise. Blizzard properties World of Warcraft and Starcraft have been stuck in hypothetical-movie development limbo for years, and the track record of video game movies is spotty at best. However, Ubisoft is perhaps the best-positioned game studio in terms of making the transition to a Disney-style (NYSE: DIS) strategy of taking beloved characters from a smaller medium and blowing them up on the big screen for blockbuster returns.

The Prince of Persia film already ranks as the highest-grossing video game adaptation of all time, and the Assassin's Creed series has both a more globally recognized game universe and a storyline that lends itself very well to a film franchise. With Prometheus and X-Men: First Class star Michael Fassbender already attached to a tightly controlled Assassin's Creed film project, Ubisoft has a lot riding on the success of a single franchise -- but it's also releasing a third Far Cry game at the end of the year, which could establish a second path for film success, as that series is also a more story-driven game than most.

Game over, press start to continue Investing in game companies rarely works out very well for long-term investors. However, there are rare developers here and there that exist at the intersection of attractive valuations and tremendous franchise growth potential. Ubisoft comes closest to that, as League of Legends is already so massive that there may not be much growth left. Its road from game studio to entertainment powerhouse won't be easy, but empires have been built on the back of a single franchise before. Disney, after all, started with a black-and-white cartoon mouse.

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Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights.

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Good article except for your CoD reference being dated. You link back to your other article which is also now dated. ATVI has now stated that its pre-orders are actually on pace to break all time records once again. Also if you're going to include Activision games or talk about how ATVI compares with competitors, leaving Skylanders out of the discussion is an enormous and glaring oversight.

On a separate note, as per your point about Zynga games inducing boredom in one day, which incidentally surprises me, that it even takes that long, I wonder how long an RTS like LOL can hold such a high level of interest. Wouldn't any arena battle grind have a much shorter peak interest shelf life than something as broad based activity wise like an MMORPG like WoW. Not being an RTS guy in part for that very reason, makes me wonder about the long term prospects of such an audience. StarCraft has done it for a very long time but with a much smaller base of hardcore RTS gamers.

Actually 12 million daily is outright wrong for LOL from what I recently just read. I read 11 million monthly and as much as 4 million daily putting its monthly total slightly higher than WoW and its daily at about par. You may want to double check your sources as that's more than just a significant difference.

I have dug up the "record-breaking" news, which apparently comes exclusively from Gamestop. I may be proven wrong, but until Activision itself releases sales figures, there's no way to be sure. I see "highest preorders in history" but no numbers from Gamestop or Activision.

I have covered Skylanders before, in the linked article and in other articles this year. I made the decision to leave it out because talking about it wouldn't have advanced my argument about franchises. Sorry. I'm sure I'll revisit Skylanders the next time Activision gives us some data.

Hey Alex. I got the record breaking news from an ATVI announcement on Oct 15 myself.

"We are seeing the highest pre-orders in history. With its current pace, this Call of Duty is on track to break records and is likely to be our biggest game launch of all time."

I posted it in the SA board for ATVI after that. Before that, some months ago, I'd also written that I imagined CoD wouldn't be able to match last release on news provided by ATVI themselves about lower than expected pre-orders. So apparently interest picked back up again between announcements. I believe your previous article came out before the last ATVI announcement.

When I search that quote, it always takes me back to GameStop, and nearly all of the articles quote a GameStop exec as having said it.

Without numbers attached to the claim, all I can do is note that it exists and offer the numbers I have as either a confirmation or a rebuttal. So far, the VGChartz numbers show weaker presales, and they're the only industry-wide presale tracking group that I'm aware of.

There's not a lot of time left before the release, so I'm sure we'll find out the truth soon enough.

This is an interesting article. I certainly agree that Zynga and its freemium-style gaming, much like Nintendo's Wii, is a gimmick that is in the midst of flaming out. Gamers ultimately want quality entertainment at a good value. I personally believe that narrative video games are some of the best ways to hold gamers' attention. For that reason, I found it interesting that you called out Ubisoft as the most likely of the Game Publishers to make the transition from the Gaming industry to the Film industry.

I'd like to ask why you dismiss Take Two Interactive so quickly. I don't have a broad knowledge of their ability to earn profits, but I certainly know that they are not a company with virtually one title, as you say. This company puts out some of the best narrative video games out there --whether it's Red Dead Redemption, LA Noire, the BioShock Series, the Civilization franchise, Saint's Row, Max Payne or Borderlands. Take Two publishes amazing games. While Grand Theft Auto is very successful, none of these other titles are slouches. The gaming community seems to be pretty darn excited about "BioShock Infinite." And all of these titles have fantastic expansions as well, extending their retail cost from the standard $60 to somewhere over $100 per paying gamer.

Again, I don't understand the economics of why Ubisoft or even Activision might be a better performing company financially (maybe they have better profit margins for a myriad of reasons), but TTI certainly has many titles, with better narrative qualities than Ubisoft by a long shot. Are any of the TTI franchises slated for movie release? I would certainly look to that company before looking to Ubisoft. I think movie goers would really enjoy the full narrative of Red Dead Redemption over the confusing Assassin's Creed time-skipping storyline.

However, this is simply my perspective as a 35 year old gamer who mostly plays console and PC games and who works on scripted television shows. As I said before, I have never looked at any of these companies' financials. I'd love to hear where you've developed your excitement for Ubisoft.